Privatizing Social Security: Still a dumb idea

You thought it was dead, but with stocks on the rise, you can expect some brand new congressmen to give it new life.

The holiday season is upon us, making this a perfect time to go searching for turkeys — the financial variety, of course. But this year, rather than looking backward at inept deals or government programs, let’s try to find future turkeys.

And the biggest one is … privatizing Social Security. Yep, privatizing Social Security, slaughtered when George W. Bush proposed it five years ago, seems about to rear its foul head again. You’d think that the stock market’s stomach-churning gyrations — two 50%-plus drops in just over a decade — would have shown conclusively the folly of retirees’ having to bet their eating money on the market. But you’d be wrong. Stocks have been rising the past 18 months, and you can bet that we’ll see a privatization push from newly elected congressmen and senators who made it a campaign issue.

Why is privatizing Social Security such a turkey? Because retirees shouldn’t have to depend on the market’s vagaries for survival money. More than half of married couples over 65 and 72% of singles get more than half their income from Social Security, according to the Social Security Administration. For 20% of 65-and-up couples and 41% of singles, Social Security is 90% or more of their income. That isn’t projected to change.

Using personal accounts to replace Social Security’s guaranteed benefit would subject people to two separate risks. First, there’s investment risk: Most people have no idea how to invest well — study after study shows that mutual fund buyers tend to buy high and sell low. But even if you manage to invest well, you run into the second risk, largely unrecognized, that interest rates will be low when you retire.

Let me show you how this works, using numbers from Vanguard. Let’s say you had $200,000 — a not insignificant sum — in the Vanguard Target Retirement 2010 fund as of Sept. 30, 2007. That was a few days before stocks peaked.

Let’s say that month you turned 66, Social Security’s current retirement age, and decided to use your $200,000 to buy a lifetime annuity from one of Vanguard’s insurance company partners. (I’m using the 2010 fund because there’s no 2007 fund; they’re offered only in five-year increments.)

Your annuity: for a single person, $1,048 a month, adjusted annually for inflation the way Social Security is. A married couple getting a joint-and-two-thirds annuity — just as with Social Security, a surviving spouse collects two-thirds of what the couple gets — would have received $881 a month.

If you turned 66 in February 2009, near the market bottom, your account would be down 29%. Your annuity — $793 and $692 — would be down 23%-24%.

But even in a decent market, you’re vulnerable. Let’s say you turned 66 on Sept. 30 of this year. Even though stocks are still down from three years ago, bonds, now more than half the fund, have done well. You’d actually be up a tad: $201,602. But your annuity would be 10% less than in 2007: $939 for a single, $792 for a couple. That’s because interest rates are down from 2007 levels. Companies offering annuities would earn less on your money than three years ago, so they offer you less. “The timing of annuitization is a big issue,” says John Ameriks, who oversees Vanguard’s investment counseling and research operations.

Of course, you could retire during a period of high stock prices and high interest rates. And if you had a private account and died before you retired, your heirs would inherit your money, as opposed to getting nothing from Social Security.

But Social Security isn’t supposed to be a gambling program, or a wealth-building program. It’s an intergenerational social insurance program, in which we make sure our parents don’t have to depend on food banks and homeless shelters when they get old, and we hope our kids do the same for us. Change that into an investment program, and higher-income people will have an advantage over lower-income types because they won’t need immediate retirement income and can wait out markets. By contrast, regular Social Security favors lower-income people — as it should.

So you see, private accounts aren’t just a turkey. They’re a mega-turkey. Happy holidays.

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